Dr. KWONG Che-leung 30 Nov 2012

1. Illustration of Elective Part II “Extension of Trade Theory, Economic Growth and Development” with authentic data Dr. KWONG Che-leung 30 Nov 2012

2. Contents Part I: Extension of Trade Theory • Production Possibilities Frontier • Comparative Advantage & its relation to Globalization • Part II: Economic Growth & Development

3. Part 1: Extension of trade theory Production Possibilities Frontier (PPF) A) Production efficient Points: Any points on the PPF  utilized all its available resources and used the best production method to produce the maximum amount of output at the current state of technology. B) Inefficient point: e.g. Point F fails to use all available resources and/or used the best production method. C) Unattainable point: e.g. Point G

4. Shift of PPF PPF shifts outward  economic growth increase the production capacity of the economy determined by the availability of factor inputs including labour, capital (both human and physical capital),natural resources and the level of technology   consumption level

5. Technology change in production of computer only How to increase? i) labour availability  a more lax immigration policy e.g. Quality Migrant Admission Scheme (優 秀 人 才 入 境 計 劃) in Hong Kong ii) Physical capital foreign direct investments (i.e. investments from abroad). Human capital enhanced by investing in education and on-the-job training e.g. Continuing Education Fund

6. Specilisation and Gains from Trade • Apart from economic growth and technological change, are there any other means to raise the consumption of both goods? Specialization and trade

7. Gains from Trade of Country A Country A has comparative adv in producing computer. Terms of trade: 1C=10F Consumption possibilities frontier C: Autarky production point = consumption point E: Production point after trade G:Consumption point after trade Gains from trade= CG units of computer

8. Country B has comparative adv in producing food. • Terms of trade: 1C=10F Gains from Trade of Country B J: Autarky production point = consumption point H: Production point after trade K:Consumption point after trade Gains from trade= KL units of food & JL units of computer

9. Conclusion • If two countries specialise according to their comparative advantages and trade is opened up between the countries, then both countries can attain higher levels of consumption of both goods, despite the fact that one country is absolutely more efficient at producing both goods.

10. PPF with increasing MC Law of diminishing marginal returns or Law of increasing marginal opportunity cost

11. Country A Gains from Trade with increasing marginal cost Point D: Country A’s autarky equilibrium Point G: Country B’s autarky equilibrium The slope of PPFa at D is smaller than that of PPFb at G. Country A has a comparative adv in producing F at production point D. Country B has a comparative adv in producing E at production point G. Country B

12. Gains from Trade of Countries A & B Country A AB – international price line- Terms of trade Country A: D- production & consumption point before trade P – production point after trade C- consumption point after trade CD- gains from trade Country B: G- production & consumption point before trade P*- production point after trade C*- consumption point after trade GC* - gains from trade Country B

13. Comparative Adv & Globalization • Economic globalization: • The process of closer economic integration of countries of the world through the increased flows of goods, services, capital and labour.

14. Pros of Globalization I. Gains from free trade: • specialisation and trade enable countries to enjoy more goods and services at lower prices • e.g. consumers in China now enjoy a wide range of products such as coffee by Starbucks and iPad by Apple.

15. Kickoff of Developing Economies: • Globalization has caused the rapid expansion of export in developing countries, • e.g. from 1965 to 1990, Japan’s export in the world market increased from about 8 % to 12 % • The rise in net export promotes economic growth. • This export-oriented strategy was later taken up • by the Four Asian Tigers (or Asian Dragons): Hong Kong, Singapore, South Korea and Taiwan.

16. In the 1970s and 1980s, the export of the Four Asian Tigers grew nearly 4 times faster than Japan’s. • They achieved exceptionally high growth rates (in excess of 7 % a year) in the early 1980s and 1990s. • The strategy was later followed by Malaysia, Indonesia, Thailand and China in the 1980s to speed up economic growth.

17. III. Promotion of Capital Growth: • According to the law of diminishing marginal returns, in a developed country (DC) with abundant capital per worker, the marginal rate of return on capital is on the decline. • On the contrary, in a developing country (or less developed country, LDC) with limited capital per worker, the rate of return on capital will be higher.  DCs have an incentive to export capital to LDCs to capture higher returns on capital and LDCs have the incentive to attract foreign direct investment to increase its marginal product of labour (i.e. labour productivity).

18. In the 1980s and 1990s, capital-abundant countries, such as the U.S. and Japan, export capital to China and other Asian countries. • The U.S. and Japan utilize the relatively cheap labour and land in China to reduce its production costs. • While China attracts foreign capital to enhance its labour productivity, technology and managerial skills. • It benefits both the capital-exporting and capital-importing countries.

19. IV. Human Capital Enhancement: • Advanced countries such as the U.S., UK, Germany and Japan have comparative advantages in providing higher education. • Huge foreign exchange earnings are generated • E.g., the U.S. enrolled about 691,000 international students with tuition and fees estimated to a total of US$13 billion during the 2009-10 academic year. • Taking into account cost of living expenses for students and their families, the total monetary income from international students is nearly US$19 billion a year.

20. Cons of Globalization I. Loss of independence: • Some argue that by not producing what we consume, we become dependent on others in terms of imports. • A good example is China’s exports of rare earth elements/metals (REEs) consisting of 17 elements which are crucial for technological products.

21. By 2010, China supplies 97 % of the world’s total production of REEs. However, China planned to cut 72 %of REEs exports in the second half of 2010, followed by a further reduction in 2011. • Japan and the U.S. accused China of using the export quota of REEs as a tool to increase its bargaining power over economic and political issues. • The problem is more closely related to the global monopoly of REEs by China rather than to free trade. • If the international trading system is free and competitive enough, substitutes will be developed and exported to the international market.

22. II. Production Concentration and Price Fluctuation: • Specialisation causes some developing countries to concentrate on a few agricultural exports (e.g. cotton • or cocoa) and on a few manufactured exports (such as clothing and textile). • They are therefore particularly vulnerable to international price fluctuations and volatile terms of trade.

23. According to a study by the United Nations Conference on Trade and Development (UNCTAD, 2002), prices paid to coffee growers have declined between 1995 and 2000 by over 50 % in 10 out of 14 LDCs which specialised in growing and exporting coffee beans. • The livelihood of the people of these countries, particularly for those almost completely dependent on one to two kinds of exports, specialisation may lead to fluctuations in living standards.

24. III. Structural Changes and Job Losses: • The opponents of globalization are not confined to developing countries. • For example, farmers in South Korea or workers in the U.S. manufacturing industries, who have lost their jobs because of the huge influx of low-price imported goods.

25. In an ideal world, laid-off workers would take up new jobs in other sectors, but it is difficult in reality as they need to acquire new skills before taking up new jobs. • Obtaining those skills takes time. More importantly, there is no guarantee that newly generated vacancies in other sectors would be enough to absorb the laidoff workers.

26. IV. Infant Industries and Acquired Comparative Advantage: • A developed country has in place a large manufacturing and capital base is relatively better at high-tech manufacturing. • A developing country with lots of low-skilled labour and a weak manufacturing base is relatively better at producing goods that require low-skilled labour, and less efficient at high-tech production.

27. Free trade under globalization predicts that the developed country will specialise and export high-tech products and the developing country will specialise and export low skilled, labour intensive products. • Free trade will keep the trade pattern stable except that infant industries (young industries) in developing countries are temporarily protected from established industries of developed countries to build an acquired comparative advantage.

28. The acquired comparative advantage can be developed by a country’s educational policies (e.g. subsidised education) and industrial policies (e.g. policy favouring the inflow of capital). • If the young industry is undercut and driven out of world markets at the beginning of its development by free trade, the acquired comparative advantage might never develop and the new industry would never exist in the developing country.

29. V. Loss of national and cultural identity: • Developing countries in Asia and Middle East have opened their economies to import from the West. Foreign brands in e.g. McDonald’s restaurant, Levi’s jeans, iPad have replaced their local products. • Though local consumers could enjoy a wide variety of imported goods, some people perceive it as damaging to national and cultural identities.

30. Conculding remarks • Free trade based on comparative advantage promotes the economic well-being of the participating countries. • However, there may be issues of distribution. • The point is how we “manage” globalization. It implies that government may need to devise policies to address the needs of the losers under free trade, or in a broader sense, globalization.

31. Tt does not mean that we should put a halt to or unnecessary hurdles on the process of globalization, though the process may not be problem-free. • Although economists disagree on many issues, the vast majority of them believe that globalization does more good than harm for the world economy.

32. Part 2: Economic Growth & Development • Economic growth refers to the rise in real GDP and/ or GDP per capita. • Economic development is a broad concept encompassing economic growth and other developmental dimensions including health, education, food, clean water, environment, equality and income distribution.

33. Development economists put high emphasis on a human development approach, that is: how the well-being of people in a country or region is improved throughout the course of economic growth.

34. Does Economic Growth Necessarily Lead to Development? • Higher economic growth represents a rise in a country’s ability to produce and to buy goods and services. It is expected that economic growth will lead to economic development as a country has more resources to provide better education, medical services, more extensive transportation networks, and so on. • This was supported by the observations on sustained economic growth beginning from the Industrial Revolution in Britain in around 1750.

35. The Industrial Revolution later spread to other countries, such as the United States, France, and Germany. The long-term economic growth since the 18th Century raised considerably the living standards of these countries in various developmental dimensions, such as provision of education, health services and infrastructure.

36. However, , there maybe negative impacts on some developmental dimensions, such as income disparity and environmental degradation. • E.g. China and India: annual growth rate of GDP up to 7 to 9 % in the past decade. • China: - Gini coefficient- 0.47 in 2010. - 40% water sources are not suitable for drinking

37. India: the 2011 Global Hunger Index (GHI) Report ranked India at 15th, among leading countries with hunger problems. India’s GHI went up from 22.9 to 23.7 between 1996 and 2011, which is categorized as an “alarming” level.

38. Measurement of Economic Growth and Development • Changes in real GDP and real GDP per capita are common indicators for economic growth and change of a country’s living standard. • However, there are shortcomings e.g. the omission of leisure, lack of adjustment for negative effects of production (e.g. pollution), income distribution.

39. Human Development Index (HDI) to analyse more comprehensively the comparative status of socioeconomic development in different countries. • The HDI is a summary measure of three developmental dimensions: health, access to knowledge (education) and standard of living.

41. Health index, education index and income index, are constructed for each of the developmental dimensions. The HDI is obtained by taking the geometric mean of the three sub-indices • The HDI ranks most of the countries (169 countries in 2010) in the world on a scale of 0 (lowest human development) to 1 (highest human development) into three groups: • low human development (0.0 to 0.499), • medium human development (0.50 to 0.799), • and high human development (0.80 to 1.0). • Hong Kong achieved a HDI of 0.862 (Rank 21) in 2010, which reflects that Hong Kong has accomplished a very high level of human development. • Japan (HDI = 0.884; Rank 11) is the only country/region ranked higher than Hong Kong in Asia.

42. Advantages of HDI • It offers a more balanced and comprehensive indicator to compare the developmental levels among different countries. • E.g. the United States clearly excels over New Zealand in terms of income level; other aspects such as health and education, New Zealand (HDI Rank = 3) is ranked higher than the United States (HDI Rank = 4).

44. Some countries, such as Chile, have a moderate income level, but its HDI ranking (Rank 45) is much higher than some high income countries such as Kuwait (Rank 47). • It does reveal that a low income country can do much better than expected, and that little human development may be accomplished even with a high income.

46. Criticisms of HDI? • In the long run, the HDI has a strong tendency to rise with per capita income, as wealthier countries can invest more in health and education, and this added human capital raises productivity. • If country rankings in GNI do not vary much with HDI ranking in the long run, a single-dimensional income index would serve as a reliable proxy for socioeconomic development, and there would be no need to worry about such things as health and education indicators.

47. There is still such great variation between income and broader measures of well-being. If the two rankings are really converging, the figure of GNI per capita rank minus HDI rank should be around 0 (e.g. range from -1 to 1).

48. HDI does not cover certain important developmental dimensions such as environmental sustainability and income distribution. no single developmental indicator can be "all comprehensive". Data constraint is a primary concern. If we want to construct one more sub-index on environmental sustainability, we need data available to all countries concerned.

49. Equal weight is given to each of the three sub-indices when compiling the HDI, which clearly has some value judgment behind it. Any other weighting, without justification, could also be subjective. In practical sense, it is difficult to judge and justify which of the three dimensions is more or less important.

50. No attention has been paid to the role of quality in HDI. E.g. there is a big difference between an extra year of life as a healthy, well-functioning individual and an extra year with a very limited range of capabilities (such as being confined to bed). Moreover, the quality of schooling counts, not just the number of years of enrolment.  while one could imagine better proxies for health (e.g. number of doctor per 1000 people) and education (e.g. teacher-student ratio), new measures for these variables must be chosen on the criterion that sufficient data must be available.